For investors, the 2020 U.S. election represents an intensely stressful version of Let’s Make a Deal.
Behind door No. 1 is a trade war, unpredictable policy shifts, and the possible stain of impeachment. And door No. 2? It could contain wealth and investment taxes, new bank regulations, and limits on oil drilling.
Investors are already in a sour mood, as evidenced by the most bearish Barron’s Big Money Poll in more than 20 years: Money managers are increasingly frustrated with President Donald Trump over the trade war and other policies, but they are frightened by Democratic candidates like Sen. Elizabeth Warren, whose tough-on-business policies could upend several industries.
Most strategists think that it’s too soon to shift their portfolios to account for election risks, but they also think that investors shouldn’t completely ignore politics. There are ways to prepare for the coming year, if only because the market is likely to overreact to polls and early ballots.
One thing is clear: Political risk has rarely been such a prominent topic for investors and corporate executives, and it’s not going away.
“I think we all wish that we could kind of go back to thinking about investing without political risks,” says Larry Hatheway, chief economist at GAM Investments, an asset manager, and head of GAM Investment Solutions. “I suspect that’s as nostalgic as anything, and unlikely to be the state of the world again anytime soon.”
Warren’s recent surge in the polls has particularly scared Wall Street. Ian Bremmer’s Eurasia Group has put her chances of winning the nomination at 40%, ahead of former Vice President Joe Biden at 30% and the rest of the field at a collective 30%. Investment banks have produced slide decks highlighting red flags for various stocks under a Warren presidency.
“She has her sights set on many industries, and we expect she would convert these into executive action on many issues,” wrote Sarah Bianchi, head of U.S. public policy and political strategy research at the investment bank Evercore ISI, in one of those decks. Warren, Biden, and Trump didn’t respond to requests to speak with Barron’s about how their plans would affect the market.
Investors always enter election season dealing with conflicting options. But some portfolio managers say they are facing a particularly confusing election year.
“In 30 years, I’ve never heard more uncertainty about the outcome,” says Lloyd Khaner, general partner at Khaner Capital Management, a hedge fund. And the odds of a particular candidate winning shift constantly. “In absolute terms, it’s just one year. But so much change can happen in a year, let alone a week or a day.”
One reason for the high level of uncertainty is political polarization. Economic policy in the past tended to be drafted by more moderate members of Congress, so fiscal policy caused fewer earthquakes in the market. Democrats often did “Republican” things, and vice versa. Bill Clinton balanced budgets, while George W. Bush expanded prescription-drug benefits for seniors. The current climate offers few examples of bipartisanship.
“For a generation—and maybe several generations—economic policy has largely been driven by a centrist coalition that was in favor of international openness and at least some degree of fiscal discipline,” says Nathan Sheets, the chief economist and head of global macroeconomic research at PGIM Fixed Income, an investment management arm of Prudential Financial. Sheets was undersecretary of the Treasury’s Office for International Affairs under President Barack Obama and a Federal Reserve official before that. “I think we’re now moving to a place where there is less in the center and there’s more polarization,” Sheets says. “That, along with the administration’s unconventional operating style, has put politics even more than before right in the center” of investment strategies, he says.
For traders sweating over the headlines, one option—probably the smartest one at this point—is to keep political prognostication out of your portfolio, and instead focus on actual policy. That is how Ben Phillips, chief investment officer for EventShares, picks stocks for the exchange-traded fund (PLCY), which focuses on small- and mid-cap names. “We tell our investors to look through the political noise and look at policy trends,” he tells Barron’s. “I think people tend to confuse politics with policy.”
That means investing in stocks that are likely to gain from policy changes that are already in place or scheduled to happen soon, like an increase in state infrastructure spending, legalized sports gambling, higher ethanol mandates, or tighter shipping-fuel standards. All of those trends are expressed in the EventShares ETF, which has returned 18% this year, behind the S&P 500 index (.SPX) but ahead of the Russell 2000 (.RUT).
That doesn’t mean investors should totally ignore politics. They can still benefit from political shifts, particularly if the market overreacts to a poll or a primary. Jay Bowen, chief investment officer of Bowen, Hanes & Co., calls such situations a “knee-jerk reaction that’s overplayed.”
Some strategists are particularly focused on investing around health care, given that sector’s vulnerability to new government regulations.
Democrats have proposed sweeping changes to health insurance, with even moderates like Biden voicing support for some form of public option like Medicare for people under 65. Medicare for All, a plan that would do away with private insurance entirely, is the preferred policy option for Warren and Sen. Bernie Sanders.
In the Big Money Poll, health care was seen by portfolio managers as the area most at risk of political disruption. Health-care funds have had net outflows of $13 billion this year through September, worse than any other sector, according to The Wall Street Journal. And the ETF (XLV) is up 8%, less than half as much as the S&P 500. Some fund managers say investors should pounce on politics-related selloffs in health care.
“We’ve seen some weakness in certain health-care stocks when Elizabeth Warren’s numbers go up or Bernie Sanders’ numbers go up, and there’s a market concern around private insurance and what that might look like under a Medicare for All scenario,” says Edward Perkin, chief equity investment officer at Eaton Vance. “That to me is a buying opportunity, not because I’m saying Elizabeth Warren can’t win. I think that even if she does win, she’s got to get it through Congress, and everything will be watered down.”
“We tell our investors to look through the political noise and look at policy trends. I think people tend to confuse politics with policy. ”
There is a similar setup in energy. Investors don’t need the excuse of the election to hate energy stocks. They have returned just 5.7% this year, largely because investors don’t believe that energy companies are good stewards of capital. Under Trump, federal policies have favored the sector. The president has packed his administration with industry-friendly administrators—including David Bernhardt, the secretary of the Interior, who is a former oil industry lobbyist—and opened new federal land to drilling. But those policies have done little for the stocks, given the larger backdrop of oversupply and weakening global oil demand.
Should Warren or Sanders get elected president, the industry would probably face extra challenges. Both have vowed to ban hydraulic fracturing, a proposal that probably wouldn’t be feasible without legislation approved by Congress. Nonetheless, analysts have gamed out winners and losers in a scenario where fracking was outlawed in the U.S. Tudor Pickering Holt released a report calling a fracking ban an “energy crisis in the making,” forecasting that oil prices would rise above $85 a barrel and natural gas would rise to $9-$10 per 1,000 cubic feet.
Perhaps counterintuitively, a ban would probably help integrated oil companies like Exxon Mobil (XOM) and pure-play oil and gas producers if prices shot higher, making conventional oil and gas production much more profitable. Refiners and pipeline companies that transport and process the products of fracking techniques would suffer, however.
A fracking ban would invariably help renewable-energy companies. That is an area that investors should already have some exposure to, given the long-term trends in energy production. Even without aggressive federal action, state mandates for renewables will help stocks like First Solar (FSLR) and Sunrun (RUN) in the years ahead.
Phillips of EventShares also thinks that investors should consider companies benefiting from higher ethanol production, given that the Trump administration has introduced rules intended to boost ethanol sales. His favorite stocks to play that trend include REX American Resources (REX) Green Plains (GPRE), and Renewable Energy Group (REGI).
Other areas whose fortunes depend heavily on political outcomes include technology and education. Both Warren and Sanders have vowed to break up Big Tech companies such as Facebook (FB), which could potentially take place without congressional approval. For-profit colleges were battered by Obama-era regulations that were lifted under Trump. A Democrat would almost certainly reinstate tougher standards, affecting companies like Grand Canyon Education (LOPE), whose stock has nearly doubled since Trump’s election. Democrats tend to spend less on defense than Republicans, so Lockheed Martin (LMT) and its competitors would be vulnerable should the White House change hands.
Politics will also affect investors’ biggest current headache: the U.S.-China trade war. Some Eaton Vance strategists, who spoke at a recent briefing in New York, said they think that Trump is highly likely to make a deal with the Chinese to boost the market and economy in an election year.
“We see cyclically weak markets, which on any resolution” will perform better, said Eaton Vance portfolio manager Ian Kirwan. “In certain areas, and particularly within Asia in markets that have been weak—automotive, semiconductors, factory automation—those types of stocks look interesting right now.”
Others, including Hatheway, aren’t so sure, noting that tension with China helps fire up Trump’s base, and he may be willing to accept pain in the market to maintain that tension. Making a benign deal to boost the market would check all of the boxes of standard political strategy.
“The orthodox approach would be for him to begin to pivot and to try to run in 2020 on the basis of the economy,” Hatheway says. “But I think all of Trump’s actions in the past three, four years would suggest that the political calculus is different.”
Given that so much in the political sphere is unpredictable, Phillips of EventShares advises investors to wait for more certainty. In the meantime, there are several areas where investors can profit from government actions without facing as much political risk.
Even though Congress and the president have made little progress on an infrastructure bill, states are spending $80 billion more on things like roads, bridges, and water-treatment plants than they did in 2013. Several companies are benefiting, including Evoqua Water Technologies (AQUA), Construction Partners (ROAD), and Granite Construction (GVA).
The Supreme Court opened the door to legalized sports gambling run by states last year, and more than a dozen states have made it legal. Phillips says that investors can play the trend by buying companies such as casino operators Twin River Worldwide Holdings (TRWH) and Boyd Gaming (BYD).
In addition, new shipping-fuel rules from the United Nations known as IMO 2020 will go into effect on Jan. 1, 2020, and they are already lifting stocks of companies like Scorpio Tankers (STNG).
“If you can spot a policy change, then you can get ahead of the potential impact on fundamentals and on stock prices,” Phillips says. “There are plenty of opportunities outside of this political debate.”
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